1. Euro area – Firing on all Cylinders …
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By David Greene – Pioneer
2. Oil – Buy the Rumour, Sell the Fact
Last Thursday’s announcement by the Organisation of the Petroleum Exporting Countries (OPEC) of a 9-month extension to its existing production-cut agreement with non-cartel members was no surprise – it had been well flagged in the preceding days. So why did the oil price plummet over 7%? It seems a classic case of “buy the rumour, sell the fact”, given that the oil price had already appreciated from a low around US$46 in early May to US$51.5 just before the OPEC announcement. Despite the fact that the terms, targets and exemptions of the extension were all the same as were agreed in November 2016, the market appears to have been expecting either a longer extension timeframe, deeper production cuts or more producers joining the pact. The agreement is an attempt by the two major players in the world’s oil market, Saudi Arabia and Russia, to rebalance the market after a dramatic 50% fall in oil prices since 2014. That fall has had a knock-on effect on the state budgets of those countries that are dependent on oil for most of their revenues. Nevertheless, the benefits of the agreement (first agreed in November 2016 and implemented in January 2017) have been slow to appear. Oil inventories continued to rise for the first three months of the year, and only recently have any signs of a decline become apparent. In part, this is due to the ability of U.S. shale oil producers to quickly increase supply as prices increase, thus filling some of the gap left by the afore-mentioned production cuts. We’ve mentioned before the close linkage between the oil price and inflation, and the chart below attests to that relationship. However, what’s interesting is that even as the oil price rebounded recently, European inflation expectations didn’t follow suit. The market is sending the ECB a strong message – they don’t believe the ECB will achieve their inflation target. We currently prefer to play the inflation theme through a normalisation of real yields, rather than outright positioning for a recovery in inflation expectations.
3. UK – Three in a Row?
The 2015 UK general election caused a significant upset, returning a Conservative majority when the bookies had a 90% chance of a hung parliament. Then last June, with the bookies being similarly confident on a “Remain” vote (although the polls were closer), the electorate voted to leave the EU. So with recent polls showing a dramatic fall in the conservatives lead, it’s no wonder that people are getting twitchy. When UK Prime Minister Theresa May surprised pretty much everyone by calling an early election, initial polls showed that the Conservatives had a healthy 20-point lead in the polls over the Labour party. Because of the UK’s rather unique “first-past-the-post” electoral system, it’s hard to translate this lead into actual seats, but political experts were suggesting that May’s majority could rise to anywhere between 50 and 100. And against that backdrop, the markets shrugged their shoulders and paid little attention. But Mrs May hasn’t had it her own way in the last two weeks. Firstly, she did a rapid back-track on the so-called “Dementia Tax”, an ill-advised suggestion that people needing care at home would have to fund it themselves until the value of their assets, including their home, fell below GBP£100,000. Secondly, it has become increasingly apparent that the Brexit choice will most likely be between a Hard Brexit and a Really Hard Brexit, as the EU negotiators stick to stated positions. Finally, inflation has picked up at the same time as growth has fallen dramatically. This week, Sterling finally took notice, falling from above 1.30 to just below 1.28 against the U.S. Dollar. Admittedly not much, because the U.S. Dollar has also been weak, but against the Euro the UK currency has fallen from 0.84 in mid-May to 0.8730 last Friday. Recently we’ve been relatively agnostic about Sterling, but have now decided to underweight the currency for the next couple of weeks, in case the depreciation accelerates.